The Court this week denied the government’s petition for certiorari in the Entergy case. As explained in our prior post on the PPL decision, this ruling was inevitable in the wake of the Court’s decision for the taxpayer in PPL. The denial of certiorari now cements Entergy’s victory in the Fifth Circuit.

The Court also denied certiorari in Historic Boardwalk, the historic rehabilitation tax credit case decided in the government’s favor by the Third Circuit. See our previous reports here.

[Note: Miller & Chevalier filed a brief in this case in support of PPL on behalf of American Electric Power Co.]

The Supreme Court this morning unanimously ruled in favor of PPL in its case involving the creditability of the U.K. Windfall tax. See our prior coverage here. The opinion was authored by Justice Thomas, with Justice Sotomayor adding a separate concurring opinion.

The Court’s opinion is fairly succinct. Viewing the government’s position as more formalistic, the Court stated that it would “apply the predominant character test [of the foreign tax credit regulations] using a commonsense approach that considers the substantive effect of the tax.” The Court stated that the regulatory test looks to “the normal manner is which a tax applies,” and “the way a foreign government characterizes its tax is not dispositive with respect to the U.S. creditability analysis.”

Applying this approach, the Court held that “the predominant character of the windfall tax is that of an excess profits tax,” which makes it creditable. By contrast, the Court found that the government’s attempt to characterize the tax as being imposed on the difference between two values was unrealistic, noting that the U.K. statute’s “conception of ‘profit-making value’ as a backward-looking analysis of historic profits is not a recognized valuation method,” but instead “is a fictitious value.” The Court agreed with PPL’s argument that the equivalency of the tax with a more typical excess profits tax could be demonstrated through an algebraic reformulation of the formula for computing the tax. The Court addressed this point in some detail, putting this opinion near or at the top of the rankings in the category of most algebraic formulas found in a single Supreme Court opinion. Declaring that it must look at “economic realities, not legal abstractions,” the Court concluded that it must “follow substance over form and recognize that the windfall tax is nothing more than a tax on actual profits above a threshold.”

Justice Sotomayor’s separate concurring opinion focused on an issue that featured prominently in the oral argument (see our report here) — namely, how the analysis is affected by the way the tax applied to a few “outlier” taxpayers who did not operate for the full four-year period governed by the tax. Echoing the position taken in an amicus brief filed by a group of law school professors, Justice Sotomayor stated that the treatment of these outliers indicated that “the windfall tax is really a tax on average profits” and ought to be viewed as a tax on a company’s value, not net income. Justice Sotomayor acknowledged, however, that her position “cannot get off the ground” unless the Tax Court was wrong in stating in Exxon Corp. v. Commissioner, 113 T.C. 338, 352 (1999), that “a tax only needs to be an income tax for ‘a substantial number of taxpayers’ and does not have to ‘satisfy the predominant character test in its application to all taxpayers.'” Since the government indicated at oral argument that it did not disagree with the Tax Court on that point, Justice Sotomayor concluded that she should not base her analysis of the case on her “outlier” argument and instead would join the Court’s opinion. Interestingly, Justice Kagan did not join the concurrence even though she was the Justice who appeared at the oral argument to advocate most strongly for the “outlier argument” made in the amicus brief.

For its part, the majority briefly noted this argument in a footnote at the end of its opinion, and stated that it would “express no view on its merits” since the government had not preserved the argument. Notwithstanding that disclaimer, the body of the Court’s opinion provides ammunition for persons who might wish to oppose Justice Sotomayor’s position in future cases. The Court stated that the predominant character test means that “a foreign tax that operates as an income, war profits, or excess profits tax in most instances is creditable, even if it may affect a handful of taxpayers differently.” Another item in the opinion that could find its way into briefs in future foreign tax credit cases is the Court’s observation that the 1983 regulation at issue “codifies longstanding doctrine dating back to Biddle v. Commissioner, 302 U.S. 573, 578-79 (1938).” In its court of appeals briefing in PPL, the government had denigrated the relevance of pre-regulation case law, stating that the regulations merely “incorporate certain general standards from those cases,” and arguing that PPL “cannot rely on pre-regulation case law—to the exclusion of the specific regulatory test—to make its case.” The Court’s opinion will lend support to litigants who want to rely on pre-regulation case law in future foreign tax credit cases.

The Court’s opinion in PPL effectively resolves the Entergy case as well. As we have reported, the government filed a protective petition for certiorari in Entergy, but it has never suggested that PPL and Entergy should be decided differently. Thus, in the near future, probably next Tuesday, the Court can be expected to issue an order denying that certiorari petition and thereby finalizing Entergy’s victory in the Fifth Circuit.

The Supreme Court this morning granted PPL’s petition for certiorari and will decide the question of the availability of the foreign tax credit for payments of the U.K. Windfall Tax on which we have reported extensively before. Seehere and here. The Court took no action on the government’s petition for certiorari in the companion Entergy case from the Fifth Circuit. That is a common practice for the Court when two cases present the same issue. The Court will “hold” (that is, continue to take no action on it) the Entergy petition until it issues a decision in PPL, and then it will dispose of the Entergy petition as appropriate in light of the PPL decision.

PPL’s brief is due December 13. The case likely will be argued in February or March, and a decision can be expected before the end of June.

(In case you are wondering why the Court is issuing orders on a day when the rest of Washington is shut down because of a hurricane, it is something of a Court tradition to stay open when the rest of the government is closed. In 1996, the Court heard oral arguments (as it is also doing today) on a day when the city was hit with a paralyzing blizzard. The Court sent out four-wheel drive vehicles to bring the Justices to the Court.)

In our previous post discussing the pending requests for Supreme Court review of the question of the creditability of the U.K. Windfall Tax, we noted that the Court had scheduled consideration of the PPL cert petition for its October 5 conference. The Court has now postponed that consideration until its October 26 conference. The reason for the change is to allow the Court to consider the PPL petition in tandem with the government’s petition in Entergy.

This postponement allows the Court to consider the issue with the benefit of an adversarial presentation. As you will recall, the government “acquiesced” in PPL’s cert petition on the theory that the Court should resolve the circuit conflict, and therefore there are no briefs in that case arguing that the Court should deny certiorari. The same is not true in Entergy, where the taxpayer vigorously argues that the Court should deny certiorari in both cases because the issue is not sufficiently significant to warrant Supreme Court review. Entergy notes that there are only three taxpayers directly affected by the Windfall Tax issue and asserts that the Third Circuit and Fifth Circuit, though reaching different outcomes on the specific issue, do not disagree “on matters of fundamental principle” regarding the foreign tax credit provisions. Rather, Entergy characterizes the circuit conflict as reflecting “an exceedingly narrow and technical disagreement” limited to how those principles should apply to the U.K. Windfall Tax. In its reply brief, the government acknowledges that there are only three directly affected taxpayers, but argues that there is a difference between the two circuits on the “proper analytical approach” to foreign tax credit issues that could potentially lead to disparate results in cases involving other foreign taxes.

As a result of the schedule change, the Court will likely announce whether it will review the issue on its October 29 order list. It is possible, if certiorari is granted, that the Court would make that announcement on October 26 in order to give the parties a head start on the briefing.

As previously reported here a few weeks ago, PPL filed a petition for certiorari asking the Supreme Court to review the Third Circuit’s decision denying a foreign tax credit for U.K. Windfall Tax payments. Given that the Fifth Circuit had decided the same issue in the opposite way in the Entergy case, there was a significant possibility that the government would not oppose certiorari, but instead would urge the Court to resolve the circuit conflict.

The government has now decided that its interests in resolving the conflict and potentially securing a reversal in Entergy outweigh its interest in preserving its victory in PPL, and accordingly it has filed an “acquiescence” in PPL urging the Court to hear the case. In that brief, the Solicitor General makes his case for why he believes PPL was correctly decided and also for why the issue is sufficiently important to justify Supreme Court review.

On the first point, the government’s brief rejects the characterization of the U.K. Windfall Tax as an “excess profits” tax. Instead, the government says, it is “a tax on the difference between the price at which each company was sold at flotation and the price at which it should have been sold, based on its ability to generate income.”

On the latter point, the government acknowledges both that the “specific question presented in this case is . . . unlikely to recur or to have significance for a large number of U.S. taxpayers” and that, “[b]y their nature, issues regarding the regulatory tests set forth in 26 C.F.R. 1.901-2(b) will necessarily arise in cases involving specific foreign tax laws that are unlikely to affect a large number of Americans.” But the government concludes that, “[n]evertheless, this Court’s guidance on the correct analytical approach for evaluating foreign taxes under Section 901 and the Treasury regulation may have significant administrative importance beyond the specific foreign tax law at issue here” and that the interest in uniform enforcement of the tax laws further justifies Supreme Court review.

Concurrent with its filing in PPL, the government filed a “protective” petition for certiorari in Entergy. In accordance with the Solicitor General’s common practice in situations where two different cases present the same issue, that document does not ask the Court to take immediate action. Instead, it asks the Court to hold the petition and to dispose of it as appropriate in light of the final disposition of the PPL case. The Court is likely to follow that advice, which means that if the PPL petition is denied, or if the decision is overturned, the Court will just deny the Entergy petition. If the PPL decision is affirmed, the Court would then grant the Entergy petition, vacate the Fifth Circuit’s decision, and remand the case for reconsideration in light of the Court’s intervening decision in PPL.

But that is getting ahead of things. First, the Court must decide whether to hear the issue at all. It has no obligation to do so, even though both parties recommend certiorari. Presumably, the Justices have not been dreaming about the opportunity to wade through the foreign tax credit regulations, and their inherent interest (or lack thereof) in the subject matter could tip the balance if they believe the question of importance of Supreme Court review is a close call.

The PPL petition is scheduled to be considered at the Court’s October 5 conference. An announcement of whether certiorari will be granted will most likely issue either on that date or on October 9.

[Note: Miller & Chevalier filed an amicus brief on behalf of American Electric Power in the PPL case.]

We have fallen behind in updating the progress of the litigation concerning the creditability of the U.K. Windfall Tax that was imposed on British utilities in the 1990s. As we previously reported, the Tax Court held in two companion cases that this tax was equivalent to an income tax in the U.S. sense of the term and hence creditable. The government took two appeals — to the Third Circuit in PPL and to the Fifth Circuit in Entergy. Those courts reached opposite conclusions, and PPL has now asked the Supreme Court to grant certiorari to resolve the conflict. (See here and here for previous posts on the parties’ briefing in these cases.)

The Third Circuit was first to rule, in December 2011, and it rejected the Tax Court’s decision in an opinion that rested in large part on arguments not made in the government’s brief. The Third Circuit focused heavily on the details of the three-part test set forth in the regulations, stating that, in focusing on the “predominant character” language in those regulations, the Tax Court had erroneously suggested that the regulation “appl[y] a ‘predominant character standard’ independent of the three requirements.” In that connection, the Third Circuit dismissed the relevance of case law that predated those regulations, notwithstanding language in the preamble indicating that Treasury did not intend to depart from that prior case law. The Third Circuit also criticized PPL’s position that the “flotation value” component of the calculation was not relevant to the three-part test because it merely defined what part of the company’s profits would be taxed as “excess.” The Third Circuit did not deny that this approach would appear to prevent any “excess profits” tax from meeting the test, but it explained that “this argument merely suggests that the regulation misinterprets the statute,” and it was too late for PPL to argue that the regulation is invalid. Finally, the court surprisingly held that the Tax Court’s decision could not be squared with Treas. Reg. § 1.901-2(b)(3)(ii), Ex. 3, an example that illustrates how the gross receipts part of the regulatory test applies in a situation where the tax base is derived indirectly from a quantity that is “deemed” to reflect gross receipts. This example is of dubious relevance to the Windfall Tax, which was based on actual profits, not a “deemed” quantity; the example was not raised in the Tax Court proceedings and was mentioned only tangentially in the government’s brief.

The Fifth Circuit had heard oral argument in Entergy a couple of months before PPL was decided, but did not issue its opinion until June 2012. The Fifth Circuit stated that “the Commissioner’s assertion that we should rely exclusively, or even chiefly, on the text of the Windfall Tax” was contrary to settled case law establishing that the form of the foreign tax is not determinative. “Viewed in practical terms,” the court continued, “the Windfall Tax clearly satisfies the realization and net income requirements.” With respect to the gross receipts part of the test, the Fifth Circuit was “persuaded by the Tax Court’s astute observations as to the Windfall Tax’s predominant character” – namely, to claw back the utilities’ excess profits.

The Fifth Circuit then addressed itself directly to the Third Circuit’s PPL decision, characterizing the latter court’s reasoning as exemplifying “the form-over-substance methodology that the governing regulation and case law eschew.” The example in the regulations relied upon by the Third Circuit is “facially irrelevant,” the Fifth Circuit observed, because “[t]he Windfall Tax relies on no Example 3-type imputed amount, nor indeed on any imputation, for calculating gross receipts.” Thus, although noting that it is “always chary to create a circuit split,” the Fifth Circuit concluded that it had to disagree with the Third Circuit and find the Windfall Tax creditable.

After its petition for rehearing en banc was denied, PPL filed a petition for certiorari on July 9. The petition emphasizes the need to resolve the circuit conflict in order to achieve uniform administration of the tax law and heavily criticizes the Third Circuit for elevating the form of the tax over its substance. For its part, the government has chosen not to seek rehearing in Entergy, bringing the schedules of the cases closer together again. A petition for certiorari in Entergy is now due on September 4. The government’s response to PPL’s cert petition is currently due August 8, but a 30-day extension is likely, which would make the response due on September 7.

The position that the government decides to take in these cases is an important factor in assessing the prospects for a grant of certiorari. Most federal tax cases heard by the Supreme Court involve clear conflicts in the circuits, and it is impossible to deny the existence of such a conflict here. But the Court does not hear every tax case that involves a circuit conflict. Rather, it agrees to hear a case only when it believes that resolution of the conflict is sufficiently important, particularly to the uniform administration of the tax laws. Historically, the Court has afforded considerable deference to the government’s advice on the question of importance. As a repeat litigant at the Court, the government is very selective in asking for Supreme Court review, on the theory that if it does not ask too often, the Court is more likely to grant its requests when it really matters. And the Court does grant a high percentage (in the neighborhood of 70%) of the government’s petitions for certiorari. Thus, in deciding whether to ask the Court to resolve this conflict, the government will weigh its own interests, including estimating its prospects for success if the Court hears the case, and make a judgment about whether it views this issue as important enough to tax administration or to the government’s bottom line to justify using one of its precious “chits.”

Although one might think that the government’s monetary interests could induce it to oppose certiorari in PPL even if were to file a cert petition in Entergy, the Solicitor General’s long-term interest in maintaining credibility with the Supreme Court would trump those short-term monetary interests. Thus, there are two likely courses of action open to the government. Either it will oppose PPL’s petition and not push for Supreme Court review in Entergy or it will file a certiorari petition in Entergy and not oppose PPL’s petition. Unless there are additional extensions, we should know in early September how the government will approach the conflict. The Supreme Court will give its answer several weeks after that.

The government has filed its reply brief in the Fifth Circuit in Entergy. (See our initial report on the case here.) The reply brief puts forth a somewhat less disapproving attitude towards the examination of extrinsic evidence in foreign tax credit cases than previously advanced, stating as follows: “The Commissioner does not contend (as he did below) that extrinsic evidence has no relevance in determining creditability under Treas. Reg. § 1.901-2(b). Rather, our argument is that it was improper for the Tax Court to supplant an analysis of the windfall-tax statute with an analysis of extrinsic evidence.”

The bottom line, however, is the same. The government maintains that the text of the U.K. Windfall Tax statute, by describing the tax using the term “value,” conclusively establishes that the tax is not an “income” tax in the U.S. sense and therefore is not creditable.

The case will now await an order from the Fifth Circuit setting a date for the oral argument, which is likely a few months away.

The taxpayer has filed its answering brief in Entergy defending the Tax Court’s decision that the U.K. windfall tax is a creditable tax for purposes of the foreign tax credit under Code section 901. See our original report here. According to the taxpayer, the essence of the government’s argument is that “the creditability of a foreign tax can be determined only by the literal text of the foreign tax statute, and that the consideration of any other evidence is legal error.” This position, the taxpayer argues, is rebutted by “overwhelming authority establishing that the predominant character of a foreign tax is measured by its intent and effect,” which requires resort to evidence beyond the text of the foreign statute.

The taxpayer also argues that the government has mischaracterized the Tax Court’s decision in stating that the court ignored the three-part regulatory test for creditability. Instead, the Tax Court correctly heard evidence of the intent and effect of the U.K. tax to determine its predominant character — namely, a tax on excess profits — and then applied the three-part test to that predominant character.

The government has filed its opening brief in the Fifth Circuit in Entergy, seeking reversal of the Tax Court’s holding that the U.K. windfall tax is a “creditable” tax for purposes of the U.S. foreign tax credit. See our previous report here. The government argues that the Tax Court misapplied a three-part test set forth in the regulations for determining whether a foreign tax is creditable. That test assesses whether the foreign tax has the “predominant character” of an income tax by examining whether it satisfies each of three requirements — relating to “realization,” “gross receipts,” and “net income.” According to the government, the U.K. windfall tax did not meet any of the three requirements because the tax was imposed on “value,” not realized “income,” and because gross receipts and expenses were not “components of the tax base.” The brief goes on to criticize the Tax Court for investigating the legislative purpose of the tax, rather than restricting its inquiry to the text of the statute.

The Third Circuit has now issued a briefing schedule in the PPL case that makes the government’s opening brief due on April 5. This schedule should have the case marching along in fairly close parallel with Entergy, the companion case presenting the same UK tax creditability issue to the Fifth Circuit. (See our previous post here.) In Entergy, the government recently requested an extension to file its opening brief. The court granted an extension, but for less time than requested. The brief is now due April 13, after a 30-day extension. That date will likely hold, since the court has already cut back an unopposed extension request. In PPL, by contrast, it is quite possible that the government will get some additional time.

About Miller & Chevalier’s Tax Appellate Blog

Miller & Chevalier was founded in 1920 as the first federal tax practice in the United States. For nearly 95 years, the firm has successfully represented the most sophisticated corporate clients in all facets of federal income taxation. Miller & Chevalier’s Tax department serves clients headquartered throughout the U.S. and around the world and, over the past several years, has represented approximately 30 percent of the Fortune 100 and more than 20 percent of the Global 100. Our clients come to us to solve the thorniest of tax issues, and we have litigated many of the most significant tax cases on record.

The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.